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Chairman Frank_ Ranking Member Bachus and Members of the




  Hearing on Enhanced Investor Protection after the Financial Crisis

                      Senate Banking Committee

                              July 12, 2011

                 Statement Submitted for the Record

                       1100 THIRTEENTH STREET | SUITE 850
                             WASHINGTON DC 20005
             202.408.8181 | FAX 202.789.0064 | WWW.EXECCOMP.ORG
Chairman Johnson, Ranking Member Shelby and Members of the Senate Banking

    The Center On Executive Compensation is pleased to submit testimony to the Senate
Banking Committee providing its perspective on Title IX of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (“Dodd-Frank  Act”). For the most part, this title of
the Dodd-Frank Act is unprecedented in its vagueness and breadth, and we urge the
Senate to take a practical view of the implications of this law and identify areas that
would benefit from a review, revision or repeal.
    The Center On Executive Compensation is a research and advocacy organization that
seeks to provide a principles-based approach to executive compensation policy from the
perspective of the senior human resource officers of leading companies. The Center is a
division of HR Policy Association and represents companies from a broad cross-section
of industries. Because the senior human resource officers play a unique role in
supporting  the  compensation  committee  chair,  we  believe  that  our  Subscribers’  views  can  
be particularly helpful in understanding the complexities that would be required to
implement the requirements set forth in Title IX of the Dodd-Frank Act.

I.   Say on Pay
    With over half of the first year of say on pay behind us, the Center has been closely
tracking the recommendations and results of Fortune 500 companies. As of July 7, 2011,
384 Fortune 500 companies had reported results on their advisory votes on compensation.
Of these companies, 378 received a majority of shareholder support (98.4 percent total
shareholder approval). The mean shareholder approval percentage is 88.6 percent, and
the median is slightly higher at 94.0 percent. The majority of companies (65.4 percent)
received at least 90 percent approval from shareholders on their compensation programs.
    The overwhelming approval demonstrates that shareholders are supportive of
executive compensation arrangements, especially for large companies. The results are
not surprising. They are consistent with the experiences in the United Kingdom, which
has had say on pay since 2002, and with say on pay votes required of TARP companies.
    Section 951 of the Dodd-Frank Act also mandated a periodic nonbinding shareholder
vote on whether companies should hold a vote every one, two or three years. As of July
7, 2011, 394 Fortune 500 companies have submitted proxies to the Securities and
Exchange  Commission  (“SEC”  or  “Commission”)  containing  recommendations  for  say  
on pay frequency votes, with the majority (68.3 percent) recommending an annual say on
pay vote. Of the 101 Fortune 500 companies that recommended a triennial frequency
vote, only 29 have received a majority shareholder vote for a triennial frequency.
     The irony in the overwhelming support for an annual frequency for say on pay votes
is that the timing of the vote and the deadlines for company compensation decisions are
out of sync. The  vote  is  on  the  company’s  prior  year’s  compensation, but for most
companies,  that  vote  typically  occurs  after  the  current  year’s  compensation  arrangements
have already been set and communicated. For this reason, a company that receives a
negative vote or a significant vote against it will take two years before shareholders will
have a say on pay vote on any changes made to pay arrangements based on the prior say

on pay vote. Accordingly, those changes will not be disclosed in the proxy for two years.
This could have the effect of moving some companies and institutions to reconsider
whether an annual say on pay vote makes the most sense.

II. Pay Ratio Disclosure
    The pay ratio provision in Section 953(b) of the Dodd-Frank Act requires companies
to disclose in their proxy statements the ratio of the median pay of all employees to the
total pay of the chief executive officer. SEC officials from Chairman Mary Schapiro to
the Director of the Division of Corporation Finance Meredith Cross, have indicated that
due to the prescriptive nature of the provision, the SEC has very little interpretive
authority with respect to this provision and thus would interpret it narrowly. For this
reason, it is likely that companies would be required to calculate the pay of every
employee globally, whether full- or part-time, in the same manner as compensation is
calculated for the named executive officers. In comments to the SEC and the media, the
author of this provision, Senator Menendez has insisted that this provision should not be
modified, despite the considerable cost and burden imposed on the business community.
     It is a common misperception that companies have this information readily available
at the touch of a button. Most global companies do not have centralized payroll systems;
therefore, generating the pay ratio information would be a considerably complex
undertaking for large, multinational companies since it would require a company to
gather and calculate compensation information for each employee, part-time and full-
time, as required for senior executives under the SEC disclosure rules, determine the pay
of each employee from highest to lowest, and then identify the employee whose pay is at
the midpoint between the highest- and lowest-paid employee. No public company
currently  calculates  each  employee’s  total  compensation  as  it  calculates  total  pay  for  
CEOs on the proxy statement; therefore, companies would be required to invest
considerable resources to implement this mandate, which will not provide meaningful
information to investors.
    Under the pay ratio requirement, the scope of the information gathering requirement
presents significant hurdles for most large companies. Accuracy is a significant concern,
since compensation data is often housed in dozens of computer systems around the globe
and subject to the compensation and benefits rules of different countries worldwide.
Furthermore, these illustrations say nothing with respect to the impact that exchange rate
fluctuations will have on the calculations. Companies would be required to develop and
coordinate a consistent calculation across all countries and then ensure that the results
were accurate since Section 302 of Sarbanes-Oxley requires the CEO and the CFO to
sign the proxy statement certifying its accuracy.
    The Center believes that pay ratio mandate is inconsistent with the purpose of the
SEC disclosure rules. The SEC generally requires that companies disclose in the proxy
statement all material information necessary to inform an investor of how and why a
company compensates its named executive officers. Material information is that which
would  impact  an  investor’s  decision  to  invest  in  the  company or its vote for directors.
Therefore, the addition of nonmaterial information simply lengthens the disclosure and
dilutes the impact of material information. Further, the inclusion of this ratio could
mislead investors who seek to compare ratios between companies.

    The ratio would not be comparable between companies as the pay of employees at all
levels of an organization is subject to various forces in the market, such as competition,
geography and job type. Companies employing more highly paid employees will likely
have a smaller ratio due to the structure of their workforce as opposed to those employing
a larger share of lower paid employees, such as retail clerks. However, the difference
would not tell investors whether the company with the lower ratio is a better investment.
Moreover,  the  ratio  does  not  account  for  a  company’s  global  operational  structure  or  
business strategy, which would certainly have an impact. One company may rely on
third parties for certain services like manufacturing or information processing whereas
another company outsources it. Again, comparing the ratios between two such
companies would provide little useful information.
    Since 2006, the SEC has made significant changes to its executive compensation
disclosure rules relating to executive compensation in an effort to expand the material
information that is available to investors. Because of these rules, the average
compensation disclosure in a proxy statement of Center Subscribers is now 26 pages.
That is over a quarter of the length of proxy statements for large companies, which now
are routinely 100 pages long. The addition of nonmaterial information in the form of the
ratio and any narrative disclosure to explain the ratio would only add to the length and
make it more difficult for investors to digest the material information

IV. No-Fault Clawback Policy
    Section 954 of the Dodd-Frank Act requires the SEC to promulgate rules directing the
securities exchanges and securities associations to develop listing standards requiring
companies to adopt and disclose a no-fault clawback policy. Specifically, the policy to
be disclosed must provide, in the event of a material restatement, for the recoupment of
incentive  compensation  that  is  “based  on  financial  information  required to be reported
under  the  securities  laws”  from  current  and  former  executive  officers  of  the  company,  if  
such compensation is in excess of that which would have been paid in view of the
restatement. This mandate raises a number of issues, including:
             Which compensation  is  “based  on  financial  information  required  to  be  
             reported  under  the  securities  laws;;”  
             The mechanics of determining the amount to be recouped in the event of a
             material restatement;
             The role of board discretion in executing the recoupment policy, particularly
             where board discretion was applied in originally awarding the incentive
             compensation, where the cost of recoupment exceeds the amount to be
             clawed back, and in determining how to recoup the excess compensation over
             what would have been received; and
             The need to provide companies with sufficient lead time to implement a
             policy before the clawback mandate takes effect.

    A. Clearly Delineate Compensation Subject to the No-Fault Clawback Policy
    The linchpin of the requirement in section 954 of the Dodd-Frank Act is that
companies are required to disclose and enforce a policy that provides for recoupment of
incentive  compensation  that  is  “based  on  financial  information  that  is  required  to  be  
reported  under  the  securities  laws.”    Thus,  if  incentive  compensation  is  “based  on”  
financial results that are reported under the securities laws, it is potentially subject to
recoupment. Consistent with principles-based disclosure and recognizing the complexity
of issues that are created by the language of the statute, the Center believes that the SEC
will need to differentiate incentive compensation that is subject to the recoupment
requirement from compensation that is not subject to it. This will enable Boards of
Directors and Compensation Committees charged with enforcing it to better understand
their obligations.
   Financial information that is required to be reported under the securities laws includes
measures such as revenue, net income and earnings per share. It also may include non-
GAAP measures such as earnings before interest, taxes, depreciation and amortization
and return on net assets.
    Incentive information that is not required to be disclosed under the securities laws
includes stock price, total shareholder return (which is based on the change in share price
plus dividends over a period of time) and operational performance measures specific to
the business such as market share and customer satisfaction. Such measures are not
financial information that is filed with the SEC and therefore would not be subject to
clawback under section 954.
    The Center believes that it is critical to understand how incentive plans are structured,
so that the SEC may factor this information into its proposed regulations. Although
compensation arrangements vary widely, depending upon the company, industry,
competitive condition and global focus, below we present five hypotheticals, illustrating
four common types of compensation arrangements:
    (1) Purely formulaic incentive plans, based on financial metrics that pay out in cash;
    (2) Formulaic incentive plans in which a pool is funded based on the achievement of
        objective financial measures, but the board has discretion whether to allocate the
        entire bonus pool toward incentives, where a recoupment would not be required;
    (3) Identical to (2), except the facts change so that recoupment is required;
    (4) Formulaic long-term incentive plans based upon financial performance with
        overlapping awards; and
    (5) Nonqualified stock option grants, that are not granted or vested based upon

     Annual and Long-Term Cash Incentive Measures Based Upon Financial Metrics.
The implementation of the recoupment policy is easiest when dealing with incentive
plans that are purely formulaic, based exclusively on financial measures, and paid out in
cash. In that situation, the clawback is the excess of what was actually received
compared to the amount that would have been received under the formulaic plans had the
financial statements been correct.

   Example 1: Formulaic Incentive Plan With Incentives Based on Financial Metrics
       Annual bonus is based on achievement of targeted level of net income.
       The performance for 2009 equaled 105% of the targeted level of net income.
       The incentive formula increases payout by 3% for each 1% by which performance
       exceeds the target.
       The payout at 100% performance is 50% of salary.
       The payout based on the performance results would be 115% of the targeted
       115% of 50% of salary would produce an annual incentive payout of 57.5% of
       Assume the performance results for 2009 had to be restated in 2011 and the
       impact was to reduce net income to 90% of the targeted level of performance.
       The incentive formula reduces payout by 3% for each 1% by which performance
       falls short of target.
       The incentive payout on the restated earnings would have been 70% of the
       targeted payout of 50% and would have produced an incentive payout of 35% of
       The amount of annual incentive that would be clawed back would be the
       difference between what was paid (57.5% of salary) and that which would have
       been paid on the restated earnings (35%), which would equal 22.5% of salary.
       Assuming the executive had a salary of $500,000, the bonus amount to be clawed
       back would equal $112,500 (the difference between an incentive of $287,500 at
       57.5% of salary and an incentive of $175,000 based on 35% of salary).

    Formulaic Incentive Plans Where Financial Measures Fund a Bonus Pool. Where the
financial measure funds a pool which is distributed based upon financial and non-
financial measures, the application of the clawback policy will differ based upon whether
the Board and/or the Compensation Committee had discretion in determining how much
of the pool to allocate for incentives and whether the Board and/or the Compensation
Committee has discretion in determining the individual awards.1 Assuming the Board or
Compensation Committee had discretion in determining the amount of the bonus pool to
allocate to individual awards and the individual awards are determined based upon some
measures that require the judgment of the board (rather than formulaic), a material
restatement could require the Board to revisit its decisions. Examples 2 and 3 illustrate
the pool concept and the role of Board discretion:

      If the Board does not have discretion (i.e., the bonus pool and the individual awards
are formulaic), the clawback would be applied similar to Example 1 for the portion of the
award based on the restated financial performance.

Example 2: Incentive Pool Approach With Restatement; Recoupment Not Required
   The annual incentive pool is generated based upon a percentage of net income,
   and at targeted level of net income for 2009 the pool would be sufficient to
   provide incentives equal to the sum of the incentive targets for the participating
   The amount of incentive payout any individual would receive is based upon his or
   her individual performance against non-financial objectives in the areas of (1)
   talent development, (2) productivity and cost-savings, (3) operational
   performance measures and (4) modeling the desired company culture and
   promoting ethical behavior (weighted 25% each).
   In total the payouts to executives cannot exceed the incentive pool, but there is no
   requirement that the board allocate the entire pool to incentive payments.
   For 2009, the company hit 100% of the net earnings target, and the incentive pool
   was generated on that basis.
   The board allocated 95% of the pool for incentives.
   No executive received an incentive payment directly based upon the achievement
   of the net income target. Some executives received incentive payments above
   their targeted incentive; some received less than their targeted level of incentive
   and some received their targeted level of incentive. The amount received by an
   individual executive was based on the assessment of performance in the four areas
   listed above.
   Assume the performance results for 2009 had to be restated in 2011, and the
   impact was to reduce net income such that the incentive pool equaled 98% of the
   sum of the incentive targets for the participating executives.
   At this restated level of performance the bonus pool was sufficient to cover the
   actual amount of incentives paid (98% pool, 95% actually paid out).
   In this situation there does not appear to be a need to recoup any of the incentives
   paid unless the board determines it would have made different individual
   incentive decisions in view of the restated earnings.

Example 3: Incentive Pool Approach; Recoupment Required
    Same as Example 2 but the restated earnings would have produced an incentive
    pool equal to 90% of the sum of the incentive targets for the participating
    The Board has three options regarding how to recoup the 5% that exceeded the
    amount allocated to the incentive pool.
     o Ratably reduce all executive incentives by 5% (non-discretionary
       recoupment although the incentive paid to each individual was based on
       board discretion);

         o Discretionary recoupment on an individual-by-individual basis (the same
           way the bonus amounts were awarded) such that the total amount recouped
           equaled the 5% overpayment (discretionary recoupment);
         o Recoupment  is  left  to  the  discretion  of  the  board,  pursuant  to  the  company’s  
           recoupment policy.
    Recognition for Board discretion in such situations is absolutely critical. Thus, the
Board should have the ability to decide to use any of the three options, so long as its
rationale  is  explained  in  the  company’s  next  proxy  statement.

    Overlapping Long-Term Awards and the Impact of a Material Restatement on Target
Setting. Long-term incentives are often three-year awards granted annually so that the
awards are overlapping. In this situation a material restatement, and any required
recoupment could affect up to four cycles of long-term incentive grants (the three
outstanding performance cycles, plus the basis for setting the next award depending on
whether the financial measures included in the restatement affect the long-term incentive
program and also serve as the base year for setting performance targets for the next
award). Example 4 illustrates the mechanics of this model:

   Example 4: Overlapping Long-Term Incentive Awards
       Assume that Performance Unit Awards are granted annually and have the
       following design:
         o Units are denominated as a dollar amount (e.g., $100,000 value for
           achieving targeted performance).
         o Performance in excess of the targeted level of performance increases the
           payout by 3% for each 1% by which targeted performance is exceeded.
         o Performance that falls short of target reduces the payout by 3% for each 1%
           shortfall in performance versus targeted level of performance.
         o The performance metric is cumulative earnings per share (EPS) over the
           three-year performance period.
       Since the awards are granted annually, and given that the performance period is
       three years, a participant will have 3 overlapping awards outstanding at any given
       Therefore, a given year will be included in three separate award cycles and,
       depending how performance targets are set, may serve as the base year upon
       which the performance targets for a 4th award cycle are set.
       Outlined below is an example of the outstanding awards under a performance unit

                                2007        2008      2009      2010        2011      2012
             2007 Award: 2007-------2008------2009
             2008 Award:                  2008------2009-----2010

              2009 Award:                            2009-----2010---2011
              2010 Award:                                      2010---2011-------2012

         Assume that in mid-2010 the company materially restates downward the
         earnings for 2009, thereby reducing 2009 EPS.
         The impact of the restatement would be to reduce the performance for the 2007,
         2008 and 2009 award cycles.
         The restatement would also lower the base year upon which the board set the
         EPS targets for the three-year award cycle beginning in 2010.
         The 2007 awards would have been paid out to the participants and therefore the
         company would have to initiate recoupment for the excess payment that was
         based on the pre-restated 2009 EPS.
         The 2008 and 2009 award periods would not yet have been completed and
         therefore the potential payout of the performance units would be automatically
         reduced. No recoupment would be required.
         The board should also revisit the targeted cumulative EPS goals for the
         performance cycle beginning in 2010 to determine if the goals would have been
         set at a lower level had the board been aware of the restated EPS for 2009 at the
         time the goals were set.

    Performance-Granted and Performance-Vested Equity Awards. Section 10D(b)(2) of
the statute states  that  the  clawback  policy  applies  to  “incentive-based compensation
(including  stock  options  awarded  as  compensation).”    The  Center  believes  this  language  
should be read as requiring that the clawback policy applies to (1) incentive-based
compensation as  defined  under  the  Commission’s  disclosure  rules  that  is  based  upon  
information required to be reported under the securities laws; and (2) stock options that
are awarded as compensation and that are incentive-based compensation as defined under
the Commission’s  disclosure  rules  where  the  incentive  is  based  on  financial  information  
required to be reported under the securities laws. This approach makes the clawback
language in section (b)(2) consistent with the reporting language in (b)(1), which requires
companies to disclose the policy of the company on recoupment of incentive-based
compensation under the securities laws.
    Applying this interpretation, the Center believes that performance-granted and
performance-vested equity awards can be incentive compensation subject to the
recoupment mandate, if the above definitions are met. Unlike nonqualified time-vested
stock options, restricted stock or restricted stock units, which are not considered incentive
compensation  under  the  Commission’s  rules,  performance-granted or performance-vested
stock options, for example, are incentives that are often granted based on financial
performance or other performance measures.

    Time Vested Stock Options. Stock options generally take one of two forms: (1)
performance-based stock options for which the granting or vesting of the award is based
on the achievement of financial performance, as discussed above or, (2) time-vesting
stock options for which the award is based on considerations other than financial

performance and the vesting of such awards is based on the passage of time and is not
contingent on achieving financial performance objectives. Stock options that vest merely
on  the  basis  of  time  are  not  considered  incentive  compensation  under  the  SEC’s  
disclosure rules and therefore should not be subject to a mandatory clawback. Many
companies determine the level of stock options granted to an individual based on the
executive’s  level,  tenure  and  expected  performance  level,  which  are  not  linked  to  
financial performance. In this case the following example should apply:

   Example 5: Stock Option Awards
       Stock option awards are determined on an executive-by-executive basis.
       The actual award received is a function of salary grade, title, performance and
       The determination of the performance of an individual executive for purposes of
       granting stock option awards is not tied directly to the financial results of the
       overall company.
       The option awards granted in 2006 have vested but the executives have not
       exercised the stock options.
       Assume the results for 2006 were restated in 2009 and the net income of the
       company was reduced by 1%.
       Correspondingly, the stock price dipped on the day of the restatement by 10% and
       has recovered over subsequent weeks but the recovery in stock price has trailed
       the overall movement of the market and the stock price appreciation of industry
       In view of the fact that there has been no gain to the executives since the options
       have not been exercised, and in view of the fact that the size of the grant was not
       influenced by the net income of the company, no recoupment is warranted.
       An alternative stock option design would be a stock option that vests on the basis
       of achieving financial targets. In this case, the number of stock options that
       would not have vested based on the restated financial performance outlined above
       would be subjected to recoupment due to the material restatement.
    In sum, the Center believes that the better way to interpret the clawback language in
section 954(b)(2) is to consider any incentive compensation that is awarded, granted or
vested based on financial measures required to be reported under the securities laws as
subject to recoupment. Conversely, vehicles such as time vested stock options, restricted
stock and restricted stock units should not be considered incentive compensation, and if
the granting of such awards was not based on the restated financial performance, it is
therefore not subject to the clawback requirement. However, if the granting of individual
stock option awards is based on the restated financial performance, the number of shares
awarded would be subject to the clawback based on the excess of the award over that
which would have been awarded based on the restated financial performance.

    B. Boards Should Have Discretion in Executing the Recoupment Policy
    In implementing the clawback requirement, the role that Board or Compensation
Committee discretion plays in setting executive compensation must be recognized, and
any regulations should explicitly provide for Board and Compensation Committee
discretion in the determination of the amount to be recouped and how that recoupment is
to be executed. This interpretation recognizes that Board discretion often plays a role in
how incentive compensation is awarded and allows the Board to make determinations to
ensure that the recoupment is in the best interests of shareholders.

    The Level of Discretion Used by the Board/Committee in Determining Amount to Be
Clawed Back Should Be the Same as That Used in Making Original Grant. Boards
should be given the same level of discretion to determine the amount to be clawed back
as was used in making the initial compensation decision. As illustrated in the examples
above, this may involve discretion under section 162(m) incentive plans in which
financial performance funds a pool to be used for the distribution of compensation to
NEOs or other executive officers. Committee discretion may also be used in applying
other financial criteria used to make individual awards.
    Board  or  Committee  discretion  is  also  increasingly  an  element  of  a  company’s  risk  
mitigation system. Affording the Compensation Committee discretion allows it to reduce
(or add) incentive payouts, when the committee takes the entirety of the circumstances
into account. In addition, long-term incentive grants, whether granted on a value or a
number of shares basis, are often made based on a formula, to which Committee
discretion is applied in determining the actual grant.

    Discretion Not to Claw Back Where the Cost of Executing the Clawback Would
Outweigh the Benefits to Shareholders. The Center believes that in addition to discretion
as discussed above, Boards should have discretion in determining not to execute a
clawback against a current or former executive officer where, for example, the amount to
be clawed back is de minimis or the Board believes that protracted litigation would be
required to recoup the compensation. In cases such as this, the Center believes the
Board’s  ability  to  decide  not  to claw back and to disclose that decision in the proxy
should be recognized. This is especially important with respect to executive officers in
certain countries or other jurisdictions that are extremely protective of employees, where
it may not be possible to recoup the entire amount. Boards should be afforded the
deference to settle a clawback for less than the full amount.
    Discretion in Determining How to Recoup Compensation From a Current Or Former
Executive Officer. The Center believes that since the statute is silent as to how
clawbacks are to be executed, Board/Compensation Committee discretion should be
explicitly recognized in executing recoupment by any method the Board deems to be
appropriate (and discloses in the next proxy statement), including cancellation of
unvested awards (equity and nonequity awards) and offsetting against amounts otherwise
payable by the company to the executive (for example, deferred compensation) in place
of having executives write a check, if the circumstances warrant. This flexibility helps to
mitigate some of the procedural complexities involved in executing a clawback, including
the need to file amended tax returns by both the company and the executives.

    C. The Three-Year Recoupment Period Should Be Linked to the Restatement
       Filing Date
     The Center also believes that the trigger for recoupment (i.e., when a company is
“required  to  prepare  an  accounting  restatement”)  should  be  when  the  company  actually  
files an accounting restatement due to the material noncompliance of the company with a
financial reporting requirement under the securities laws. This creates a verifiable date
certain from which to determine the three-year period over which the recoupment applies.
It also avoids speculation over when a company determined it should have known it was
required to prepare a restatement.
    The Center believes that restatements based on changes in Generally Accepted
Accounting Principles should be excluded from the types of restatements that trigger a
recoupment. These restatements are not based on oversights or deliberate errors by the
company, but rather a change in the framework for reporting. Mandating a recoupment
in such circumstances does not fulfill the policy objective sought by the clawback
mandate: namely, if an executive did not earn incentive compensation based on financial
results, he or she should be required to return it.

    D. Include Sufficient Lead Time to Implement the New Clawback Requirements
    The Center believes that the clawback policy will apply only to any new incentive
compensation that is received after the effective date of the listing standards approved by
the Commission. To apply the recoupment policy to compensation already granted
would create excessive complexity in term of amendments required to outstanding
compensation plans and executive contracts.
     In addition, the Center stresses that companies need sufficient time to put such
policies into place prior to the effective date of the listing standards incorporating the
disclosure and recoupment obligation taking effect because of the considerable number of
issues, such as plan amendments and contract renegotiation that must be addressed. We
believe that a reasonable time would be 12 months after the Commission approves the
listing standards.

III. Disclosure of Pay Versus Performance
     Section 953 of the Dodd-Frank Act adds a new section 14(i)(a) to the Exchange Act,
entitled Disclosure of Pay Versus Performance, which requires that public companies
disclose  in  its  annual  proxy  statement  “information that shows the relationship between
executive  compensation  actually  paid  and  the  financial  performance  of  the  issuer.”    The  
Center believes there is a critical need for flexibility with respect to this disclosure in
order to properly portray the unique aspects of individual company pay philosophies,
programs and decisions. The statute requires companies to take  “into  account  any  change  
in  the  value  of  the  shares  of  stock  and  dividends  of  the  issuer  and  any  distributions.”    We  
believe this disclosure  should  reinforce  the  purpose  of  the  CD&A,  namely  to  “put into
context the compensation disclosure provided elsewhere.”2

 U.S. Securities and Exchange Commission, Executive Compensation and Related Person Disclosure,
Release Nos. 33-8732A, 34-54302A, 71 Fed. Reg. 53,157, 53,164 (September 8, 2006).

   With  this  in  mind,  the  Center  believes  this  disclosure  should  reflect  the  Board’s  and  
Compensation  Committee’s  perspectives  on  compensation and financial performance in
making its compensation decisions. Rather than focus on uniform disclosure, the
requirement in new section 10(i) should be interpreted to focus on explaining the link of
compensation  “actually  paid”  to  performance, allowing companies the flexibility to
explain  the  committee’s  decisions  in  the  context  of  its  overall  pay  philosophies.

     Definition  of  Compensation  “Actually  Paid.”    We  believe  that  the  determination  of  
“actually  paid”  will  vary  based  on  how  the  Compensation Committee and the Board
structured the performance basis of incentive compensation granted to executives. This
is  consistent  with  the  requirement  that  the  CD&A  “focus  on  the  material  principles  
underlying  the  registrant’s  executive  compensation  policies and decisions and the most
important  factors  relevant  to  analysis  of  those  policies  and  decisions.”3
    Because much of the CD&A focuses on the amounts in the Summary Compensation
Table, the intended performance linkage between pay and performance may not be clear
from the amounts in that Table, depending upon the philosophy of the company,
especially with respect to long-term incentives. The linkage between pay and
performance is fairly consistent as it relates to salary and annual incentive because the
amounts realized are reported in the same year as the corresponding performance.
However, the design of long-term incentive plans can vary considerably among
companies depending on the basis upon which awards are granted, performance periods,
performance objectives and incentive vehicles used.
    Long-term Incentives as Awards for Past Performance. For example, a
Compensation Committee may grant long-term incentives as a reward for past
performance. In this case, the grant date fair value estimate for long-term equity-based
incentives in the Summary Compensation Table more appropriately reflects the decisions
made by the Compensation Committee and the Board and thus the linkage between
compensation  “actually  paid”  and  performance.    

    Example 1: The Company has a tremendous year in terms of financial performance
and the senior executive team is granted above guideline stock option awards to reflect
the accomplishments of the prior year in the total planned annual compensation value. In
this case, the Compensation Committee and the Board would discuss the relationship
between the financial results and the date of grant value of the stock option awards, as
reported in the Summary Compensation Table, when combined with other forms of
incentive compensation reported in the Summary Compensation Table, as reflecting the
relationship of pay and performance. If performance had been below expectations, a
lower planned grant value could result. This pay for performance philosophy is in large
part backward looking in that long-term incentive grants are the result of past
   Alternative:  Realized  Compensation  as  “Actually  Paid.” By contrast, some
companies are concerned that the long-term incentive estimates disclosed in the
Summary Compensation Table do not completely reflect the pay for performance linkage
underlying  the  committee’s  decisions.    As  a  result,  they  may  choose  to  put  those  amounts  

    Id. at 53,242.

into context by discussing how compensation actually realized -- the compensation
actually received by the executive at the end of the performance period based on the
degree of achievement of the underlying performance objectives -- is the proper
reflection of pay for performance rather than grant date value of the award.4 This
approach requires an explanation of how pay and performance were linked over the
period the awards were outstanding and gives shareholders a sense for how such forward-
looking incentive programs operate in practice.5
    Example 2: The Company is in a turnaround situation and the Compensation
Committee believes that it is important to grant a market-competitive level of long-term
awards to the executive team to motivate them to improve the performance of the
company. In this case, the philosophy of the company is that the link between pay and
performance is best reflected based upon the pay that will be actually realized by the
degree to which performance goals are achieved and the long-term awards create gains to
the executives. This pay for performance philosophy is forward looking in that future
performance will determine the pay received from the performance-contingent awards.
Some companies have begun disclosing the realized value of long-term incentive
amounts in a table, similar to the following (which is separate from example 2):

    Form of          Total           Annualized      Performance Results Over Performance Period That
    Compensation     Received ($)    Amount          Produced the Compensation

     2008-10 LTIP    $3,384,275      1,128,092       The total 2008-10 Long Term Incentive Plan award was
     Payout                                          $3,384,275. Performance criteria for this award were:
                                                     (1) Total return to shareholders vs S&P Industrials Index
                                                     companies, weighted 50%, for which the company ranked
                                                     in the top 25 percent of companies, producing a near
                                                     maximum payout for this component.
                                                     (2) ROIC, weighted 25%, which exceeded the targeted
                                                     level by 100%, resulting in maximum payout; and
                                                     (3) Cash flow, weighted 25%, which exceeded the target
                                                     by 15%, which resulted in a target payout.
                                                     Overall the payout represented 150.25% of target.

  This approach is also reflective of the way the Commission has distinguished estimates of compensation
included in the Summary Compensation Table and compensation earned and paid out in the preamble to its
2006 disclosure release. See, e.g., U.S. Securities and Exchange Commission, Executive Compensation
and Related Person Disclosure, Release Nos. 33-8732A, 34-54302A, 71 Fed. Reg. 53,157, 53,169
(September 8, 2006) (“This  table,  as  amended,  shows  the  named  executive  officers’  compensation  for  each  
of the last three years, whether or not actually paid out.”) referring to the Summary Compensation Table);
Id. at 53,174(“No  further  disclosure  will  be  specifically required when payment is actually made to the
named  executive  officer.”) discussing the treatment of equity awards on the Summary Compensation Table.
  This approach may also be useful in turbulent economic times where the accounting estimate of long-term
incentive awards included in the Summary Compensation Table may vary considerably from the amounts
actually realized.

     As the two examples above demonstrate, it is important that there is flexibility for the
Compensation Committee and the Board to present the pay for performance relationship
in  a  manner  that  is  consistent  with  the  company’s  pay  philosophy.
    Regardless of the approach used to describe the relationship between incentives and
performance, the Center does not believe that the actuarial increase in defined benefit
pension  plans  should    be  included  in  the  calculation  of  compensation  “actually  paid”  
because the amounts are based on credited service, age, interest rates, and historical
earnings, factors not generally related to financial performance, and given that pension
estimates have not yet been received by the executive and thus should not be considered
pay actually paid. The Center also believes  that  “other  compensation,”  should  be  
excluded as it is not related to financial performance.
     Definition of Financial Performance Should Be Company-Specific. We believe that
the  definition  of  “financial  performance”  should  link  the  compensation  “actually  paid”  to  
the financial metrics the Compensation Committee and the Board have incorporated into
the  company’s  incentive  plans.    Companies  choose  these  financial  measures  because  they  
link to short-term and longer term financial objectives intended to drive long-term
shareholder value that will ultimately be reflected in stock price. We suggest that a
company be required to clearly state the extent to which financial performance measures
are  used  in  determining  the  incentive  compensation  “actually  paid”  to  named  executive  
officers and how those amounts relate to financial performance.

    Example 3: For example, a company that links its long-term incentives to financial
performance  may  state:    “our  company  provides  a  long-term incentive program for senior
executives that is paid out in shares of company stock at the end of the period, based on
the achievement of certain financial results. A certain number of performance share units
are granted at the beginning of the three-year performance period and adjusted based on
performance at the end of the period. The financial performance on which the payout is
based is:
            60% Earnings per share;
            20% Return on Invested capital; and
            20% Cash flow.”
    The company would then provide the pay (either on an estimated basis or realized pay
basis) that is linked to the financial performance.
    Companies should be permitted to incorporate into this disclosure comparison of how
other, nonfinancial measures compare with performance, consistent with the
Commission’s  existing  disclosure rules, so long as the link between financial
performance and compensation actually paid is clear. This approach would allow
companies to describe the link between pay and the performance on which it is based,
whether financial, operational or strategic. Companies that base compensation decisions
or measure performance based on financial and operational measures would report the
compensation decisions or compare compensation received with the achievement of those
objectives, while companies that base compensation actually paid on total shareholder
return would measure performance on that basis.

    Example 4: Company A determines a total long-term incentive value based on the
committee’s  evaluation  of  the  external  market  and  allocates  that  total among two long-
term incentive vehicles:
            40% time-vested stock options, which vest after three years and provide value
            if  the  company’s  stock  price  exceeds  the  grant  price; and
            60% performance shares, which are based equally upon the achievement of
            earnings per share and total shareholder return measures.
    In this case, only the performance shares are related to financial performance.
However, rather than requiring a separate disclosure in which the company shows the
link between the portion of the long-term incentive that was based on financial
performance and compensation, the company should be able to disclose how each
element of the long-term incentive produced or is expected to produce compensation
based  on  performance  (depending  on  the  committee’s philosophy in granting
compensation as discussed above), and to highlight the elements that are based on
financial performance.
    Of course, as is the case under current SEC disclosure rules, companies would not be
expected to disclose non-public performance metrics that would lead to competitive harm
if disclosed to competitors.
    In sum, compensation is not a one-size-fits-all exercise, and companies use different
approaches that fit their size, industry, strategy, competitive outlook and talent retention
and development needs. A principles-based approach should be implemented with
respect to disclosure of the relationship between pay and performance in order to promote
clearer shareholder understanding of the decisions made by a Compensation Committee
and/or the Board.
V. Incentive Compensation at Covered Financial Institutions
    Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
requires the Agencies to promulgate regulations that prohibit incentive-based
compensation that may encourage inappropriate risks by a financial institution by
providing excessive compensation or that could lead to material financial loss. The
Center is extremely concerned that the proposed rules are so prescriptive that they will
effectively undermine the ability of covered financial institutions, especially those that
are publicly held companies, to appropriately tailor compensation to performance for
executives and other employees. The Center urged the Agencies to reconsider the
prescriptive nature of these rules and to reshape these rules as guidelines to give the
boards of directors of covered financial institutions the leeway and authority to govern a
company effectively while accomplishing the statutory mandate of section 956.
Allocating decision-making authority between the board, shareholders and the
government as proposed will create disjointed programs that are likely to negatively
affect company performance without adding measurably to the safety and soundness of
the institutions.
    While the guidelines required by the Dodd-Frank Act were mainly in practice at most
financial institutions, the regulations that have been jointly proposed by the Securities
and Exchange Commission, Office of the Comptroller of the Currency, Board of
Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office

of Thrift Supervision, National Credit Union Administration and the Federal Housing
Finance  Agency  (collectively,  the  “Agencies”)  have  exceeded  that  statutory  mandate  and  
could negatively affect the financial services industry at a time promoting the economy
and ensuring stability in this industry is a principal focus.
    The  following  summarize  the  Center’s  primary  concerns  with  respect  to  the  proposed  
        Section 956 of the Dodd-Frank Act should be implemented in a Board-centric
        manner which draws on the informed judgment of the Board. Equipped with
        intimate  knowledge  of  the  company’s  business  and  talent  strategy,  the  Board,  is  
        supported by the advice and council of independent expert advisors and is
        uniquely qualified to design and monitor incentive arrangements that are in the
        best long term interests of shareholders. Failing to maintain and reinforce the
        Board’s  unique  role  in  managing  compensation  will  create  disjointed  programs
        that are likely to negatively affect company performance without fulfilling the
        purpose of this rule – to improve the safety of financial institutions and mitigate
        unnecessary and excessive risk. This is especially the case with respect to
        executive compensation.
        Consistent with the duty to manage incentive arrangements in an informed and
        careful manner, Boards should continue to have responsibility for risk mitigation.
        Since the beginning of the economic downturn, companies took steps to minimize
        risk prior to government intervention. Accordingly, companies with strong
        corporate governance have involved the risk management function in discussions
        regarding compensation. The Center believes that the proposed regulations
        should recognize the initiatives Boards have undertaken to manage risk and adopt
        a flexible approach which allows Boards to adopt the most appropriate risk
        mitigation strategies for a company.
        Most companies seek to minimize risk in incentive compensation through
        multiple levels of review -- an appropriate and reasonable approach consistent
        with sound governance. These best practices should be recognized and
        accommodated in the rules. Requiring all companies to adopt a one-size-fits-all
        approach to risk mitigation is an overly broad reaction as most institutions already
        have in place a well-defined governance structure to assess risk in incentives.
        Additionally, companies should be free to allocate responsibility for risk
        management as appropriate for their business structure. The proposed regulations
        contemplate dictating a governance structure with respect to the compensation
        committee’s  responsibilities  in  reviewing,  assessing  and  approving  compensation  
        for all individuals that have the ability to expose the institution to loss. Consistent
        with the oversight role of the Board, the responsibility for mitigation of risk in
        incentives below the executive level should be company management, and the
        Board should have responsibility to ensure processes are in place, and monitor
        such processes, to ensure risk mitigation is appropriate.
        The mandatory deferral provision in the proposed regulations exceeds the
        Agencies’  statutory  mandate  and  is  contrary  to  a  Board-centric approach to
        compensation. The Center is concerned that this requirement will lead to a
        “cookie-cutter”  approach  to  executive  compensation  among  large  financial  

       institutions. Moreover, the requirement raises a number of questions with respect
       to how it will be interpreted and implemented, because it is drafted in such vague
       and ambiguous terms.
       The determination of what constitutes excessive compensation is best left to the
       judgment of the Board of directors. The Center believes that the Agencies should
       take a principles-based approach that would allow companies to develop
       compensation programs that are appropriately structured for the company and to
       discourage executives from taking excessive risk. Incorporating flexibility in
       these rules ensures that Boards can tailor the compensation programs – especially
       with respect to the competition for talent -- to reflect the unique company-specific
       facts and circumstances that surround each compensation decision.
       To the extent that the proposed regulations are duplicative of existing regulations,
       the Center requests that the Agencies consider removing the duplicative
       provisions. The annual report requirement is excessive, unclear and is redundant
       with many provisions that are already required to be filed under existing SEC
       disclosure rules and existing financial regulatory agency guidelines.
       As the proposed regulations are currently drafted, it is not always easy to
       determine which of the seven Agencies would be the appropriate regulating
       agency. This could lead to confusion in the future as each agency is permitted by
       the regulations to establish additional guidance. It is common for financial
       institutions to have two or more divisions that fall under a single corporate entity;
       therefore, it is possible that separate divisions could fall under the purview of
       different regulating Agencies with potentially inconsistent or contradictory
       requirements. The Center seeks clarification regarding the appropriate regulating
       agency rules.

    The Center appreciates the opportunity to provide its views on this extremely
important policy matter. We look forward to working with you and members of your
staff to ensure that the Dodd-Frank Act will lead to the positive reform that was intended
when it was enacted.


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